Humana Inc.
–
Managing a Changing Business
Ashutosh Dash
Humana – The Issues
Identify the need for Restructuring
Identify alternative approaches
Correctly choose the alternative based on value gains
Analyze interaction between Strategy and Policy
Identify the need
for Restructuring
Restructuring - For Risk Management
Response to external changes
- Increased competition
- Policy changes
- More efficient technology
- Emergence of new markets
- Emergence of new products
- Demographic Changes
- Business cycles
Humana - Need for Restructuring
Integrated strategy is no longer profitable
No longer it control patient flows and occupancy rates
Hospitals and health plan businesses seems incompatible
Success of HMOs comes at the expense of hospitals
Humana hospitals not referred by other HMO competitors
Deteriorated relations between Humana and physicians
Patient Flows – Synergy that reversed
Kaiser Permanente – A Comparison
Kaiser, unlike Humana, is a nonprofit organization
Contents to operate hospitals as cost centers
Started out as a managed care provider, and later entered
the hospital business
The ratio of health plan enrollees to hospital beds was
much more favorable for Kaiser
In 1992, ratio was 851:1 for Kaiser, and 99:1 for Humana
Problems with unbundled business
Hospitals HMO
Severe excess capacity, Rapid growth in total
Declining operating HMO enrollment
margins, High growth does not
Unfavorable shifts in the necessarily translate into
patient mix high profitability
Cost control of HMOs High administrative cost
and medical loss ratio
Growth for acquisitions
Identify
Alternative
Approaches
The Form of Corporate Restructuring
Restructuring Activity
Potential Strategy
Corporate Portfolio
Redeploy Assets
Mergers, Break-Ups, & Spin-Offs
Restructuring
Balance Sheet Acquisitions, divestitures, etc.
Assets Only
Increase leverage to lower cost of capital or as a
Financial Restructuring takeover defense
(liabilities only)
Divestitures, widespread employee reduction, or
Organizational Restructuring reorganization
Alternative Forms of Restructuring
Corporate
Restructuring
Portfolio Restructuring Financial
Restructuring
Entry Exit
Strategy Strategy Debt &
•Mergers •Spin Off Equity
•Acquisitions •Split Off Restructuring
•Divesture •IPO/Buyback/
Stock
Split/LBO
Forms of Restructuring
Mergers & Acquisitions
Demergers
Spin Off
Split Up
Split Off
Divestures
Carve outs
Buy-Back
Capital reduction
Spin-Offs
Stage 2
1
Parent Parent Firm Parent Parent Firm
Firm Shareholders Firm Shareholders
Subsidiary Stock Parent Shareholders Subsidiary
Paid to Shareholders Own Both Parent & Independent
Subsidiary As Dividend Subsidiary Stock of Former
Parent
Equity Carve-Outs
Initial Public Offering Subsidiary Equity Carve-Out
Private Firm Sells Parent Firm Sells Cash Public/Private
A Portion of Its Equity A Portion of Its
Equity Markets
to the Public Subsidiary Stock
to the Public
Stock Cash
Subsidiary Stock
Public/Private
Subsidiary of
Equity Markets
Parent Firm
Tracking Stocks
Parent Firm Value of the
Tracking Stocks
Parent Common Tracking Stock
Issued by the
Sub 1 Tracking Stock Depends on the
Parent Firm
Sub 2 Tracking Stock Performance of
Subsidiary
Sub 3 Tracking Stock
Subsidiary 1 Subsidiary 2 Subsidiary 3
Split-Offs
Stage 1 Stage 2
Parent
Former
Parent Stock Parent Firm Parent
Parent Firm
Firm Shareholders Firm
Shareholders
• Subsidiary stock
Subsidiary
Subsidiary Stock now held by former
Independent
Subsidiary parent shareholders.
• Parent has no of Former
Parent
relationship with former
subsidiary
Choosing Appropriate Restructuring
Choice heavily influenced by the following:
Parent’s need for cash
Degree of operating unit’s synergy with parent
Potential selling price of operating unity
Implications:
Parent firms needing cash
more likely to divest or
engage in equity carve-out for operations
Parent firms not needing cash
more likely to spin-off units exhibiting low selling prices and synergy
Parent firms with moderate cash needs
likely to engage in carve-out when unit’s selling price is low
Tax Issues in Restructuring
Central Tax
Issue
Recognition Non-recognition
Event Event
18 08/30/2020
Tax Issues in Deals
Business Combination or Demerger may be:
A taxable deal
Tax-free transaction
Tax free so long as certain statutory and judicial conditions are
satisfied
In taxable transaction, selling company realizes a taxable gain
or incurs a deductible loss
In tax-free event, no immediate tax effect but tax consequence
to each individual is deferred till disposal
Taxable and Non taxable structures
Taxable Transactions Non Taxable Transactions
Statutory cash Mergers Statutory Stock Mergers (Type A
Reorganization)
Purchase of Stock with Cash Stock for Stock purchase (Type B
Reorganization)
Purchase of Assets with Cash Stock for Asset purchase (Type C
Reorganization)
Triangular Statutory Cash Merger Triangular Statutory Stock Merger (Type
G & H Reorganization)
20 08/30/2020
Choose
Alternative Based
on Value Gains
Value in case of Divesture
EBITDA Multiple
Proceeds from Divesture 824.5 6 4947
Un-depreciated value of PPE 2573 80% 2058.4
Less Medicare Recapture 584
Capital Gain 2304.6
Tax 783.564
Proceeds from Divesture 4947
Less Tax 783.564
Less Medicare Recapture 584
3579.436
How Spin off Can Create Value?
Investors put a higher value on "pure plays“
Existence of a stock market inefficiency
Humana's price-earnings multiple:
Before the spinoff (10x)
Average multiple for stand-alone HMOs (26x)
Can increase the firm's combined cash flows because of
improved management incentives
Eliminating the negative synergies that arose under its
integrated strategy
Value based on Spin-Off
HOSP HP CORP
EBITDA 904.00 100.00 (159.00)
79.50 79.50 159.00
824.50 20.50
EV/EBITDA 9.4 9.2
EV 7750.3 188.6 7938.9
Debt 846
Equity value 7092.9
Value per Share 44.84
Value based on Spin-Off
HOSP HP CORP
EBITDA 904.00 100.00 (159.00)
79.50 79.50 159.00
824.50 20.50
Interest Expenses 193.00 (36.00) (123.00)
(123.00) 123.00
70.00 (36.00) 0.00
Dep 210.00 26.00 20.00
10.00 10.00
220.00 36.00
Pretax Income 534.50 20.50
Tax 213.80 8.20
EAT 320.70 12.30
EPS 2.03 0.08
P/E Ratio 15.00 26.00
Value Per Share 30.41 2.02 32.43
Equity Value 5130.30
What Happened???
Spun off hospitals business renamed Galen Health Care
Long term debt ($690 million) was assumed by Hospitals
for financial flexibility of health plan
Agreement to maintain business relationships for 3 years
Hospital to provide services to members of Health Plans at a
concessional scheme
Health Plans required to use Hospitals' facilities by a
minimum guaranteed annual amount or penalty
Give hospitals the right to match the rates of any other
hospital services provider that Health Plans wished to use